Is it time to take profits from shares?

OVERVIEW FOR THE MONTH

• The New Zealand equity market returned 0.97% in May while the Australian market returned 0.40% (+4.08% in NZD terms) over the month.
• The MSCI World equity index fell -0.1% in May. Bond markets reacted cautiously to stronger European and US economic data and Fed comments that it will likely be appropriate to take initial steps to start normalising monetary policy at some point this year. The US dollar strengthened in reaction. The S&P500 index rose 1.1% as soft economic data pushed out expectations of the Fed’s first rate rise to September. European markets were weaker with Greek exit concerns offsetting European economic recovery evidence. Chinese markets rose 2% as investors reacted positively to capital account liberalisation and monetary policy easing. 
• The NZ equity market fell as yield investor enthusiasm for Spark, Meridian and Mighty River waned as long term Government bond yields increased. Further new equity issuance (including $152m by Kiwi Property) and expectations of large shareholder block sell downs (including Chevron’s exit of NZ assets, which occurred in early June for $867m) may also have constrained investors. The March period reporting season was generally positive with increases to market earnings forecasts post results, with Mainfreight, F&P Healthcare and Nuplex the standout ‘beats’ versus analyst forecasts.
• New Zealand business confidence weakened over May, led by sharp declines in the agricultural sector. This points to a softening in the pace of activity.  With inflation risks low, the introduction of macro-prudential policies increases the case for RBNZ rate cuts.
• In Australia, capital raising by the banks to bolster capital ratios, including an A$5.6bn equity raising by NAB and an A$2bn dividend reinvestment equity raising by Westpac, weighed on the market.  RBA rate cuts supported domestic cyclical and property stocks. Offshore earners outperformed on AUD weakness.  The RBA signalled its reluctance to cut interest rates further due to risks of a housing bubble, indicating the outlook for rates would depend on economic data.

Yielding assets have been overbought as investors have ‘boot-strapped’ up the risk curve to maintain income streams in an ultra-low interest rate environment. While normalisation of global monetary policy settings may be slow,  decompression of yield investments from ‘over compressed’ levels may be painful for some investors.

We don’t expect long term interest rates to increase significantly. However  even a ‘low and slow’ unwinding of global easy monetary policy settings (as deflation concerns recede in the US and Europe) will require an adjustment to asset pricing assumptions currently baked into capital markets.  Capital markets don’t do ‘low and slow’ very well – they tend to do hard and fast and overshoot. While there may be an increase in volatility and a repricing of assets on change in monetary policy direction,  ‘low and slow’ rate rises are still conducive to ‘okay’ equity market returns.
After contracting in recent month’s global industrial production (IP) is expected to increase.  ISM manufacturing new orders, a strong global leading indicator, rebounded in April after five consecutive months of decline. The monthly uptick is consistent with global IP momentum accelerating in the second half of the year. In early June, US employment payroll data was more positive than expected.